Balancing State Balance Sheets

February 26, 2013

Throughout the world, states, not just federal governments, must deal with the state of their fiscal situation. Great attention is typically paid to states' liabilities but not to their assets. Instead of short-sighted government interventions, states can take free market steps to begin rebalancing their balance sheets, says Michael Spence, a Nobel laureate in economics.

  • In the past states owned industrial assets, which performed inefficiently when protected from competition.
  • This led to privatization around the world, particularly in Europe, which eliminated the ability of the state to favor its own enterprise through public procurement, hidden subsidies and regulation.
  • Where state ownership does not exist, regulations can equally shelter sectors, creating inefficiencies and low productivity in the absence of competition.

Growing long-term liabilities reduces the ability of the government to react to shocks or structurally readjust the private sector.

  • States have relatively invisible assets, including land, mineral rights, infrastructure and public pension funds, the last of which is already spoken for but still an investment mechanism.
  • While small asset sheets reduce the ability for states to deal with market failures, unsustainable growth and the unintended effects of shortsighted regulation, large assets sheets create the distinct possibly of ineffective public management, which creates market inefficiencies and hinders innovation.

Spence advocates a model in which states, acting as a financial investor, hold and manage a diversified portfolio of assets that increase the resilience and flexibility of that state to adjust to periodic systemic financial risk. He suggests two actions that can be taken to accomplish this.

  • Instead of burdening future generations, states should make a choice about the desired levels of social insurance and then fully fund any liabilities that result.
  • Governments should save for a rainy day to help weather periods of rapid change, high volatility and variable systemic instability.

Source: Michael Spence, "Rebalancing the State's Balance Sheet," Project Syndicate, February 18, 2013.

 

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